Complementarity between Merit Goods and Private Consumption: Evidence from estimated DSGE model for Japan

This study constructs a dynamic stochastic general equilibrium model and empirically investigates the effects of fiscal policy in Japan with focus on the functional difference in government expenditures. Specifically, we divide government consumption into merit and public goods and examine their external effect on private consumption. Our estimation using Japanese quarterly data from 1981:Q1 to 2012:Q4 indicates that merit goods are complements for private consumption, while public goods are substitutes, and consequently, the expenditure on merit goods has greater positive effects on the economy than public goods. Furthermore, we show that Japanese government expenditures are highly persistent and their response to the GDP gap and national debt accumulation is limited. These findings suggest that the complementarity between private consumption and merit goods is a major factor causing a fiscal crowding-in effect on private consumption.